Every organization whether it is a big multinational company or small local company requires loan at one point of time in order to finance its operations and majority of companies which take loan will repay it to lender. Let’s look at the journal entry which will be passed in the books of account of the company when company makes loan repayment –
Loan outstanding account Dr
Interest on Loan outstanding account Dr
In the above entry since loan is outstanding it will be debited, so that in the books of account of the company it is closed and on any debt the company which has taken debt has to pay interest on debt and that is the reason why interest on loan is debited as it is an expense for the company (Remember the rule debit all the expenses and losses) and since cash has gone out of business cash account will be credited.
It can be better understood with the help of an example, Suppose ABC firm has taken loan of $ 500000 and interest rate is 10 percent and firm repays the loan exactly after 1 year then entry on loan repayment date will be
Loan outstanding a/c Dr $ 500000
Interest on Loan a/c Dr $ 50000
To cash a/c $ 550000
As one can see from the above that on repayment of loan outstanding account is debited so as to close the loan account and interest on loan for the year is also debited and since cash has gone out of business it is credited with full amount of $ 550000. This was a simple example, in real life it is much more complex because companies take multiple loans and that too are not of same maturity and hence in such cases interest calculation and repayment calculation is quite complex.